In Private Letter Ruling 202432012 (August 9, 2024), the Internal Revenue Service determined that the proposed judicial modifications of the distribution and custody provisions of the tax-exempt trust (GST) were acceptable under Treasury Regulations Section 26.2601-1 (b )(4)(i) and will not be subject to trust GST tax.
Changes are required in court
The last to die of the settlor and her spouse, the settlor's will created trusts for her descendants. Such a trust created – the said trust – is a GST-exempt trust created for the benefit of one of the settlor's children and that child's descendants. The trustee of the said GST-exempt trust asked the court to modify the trust. The court issued an order granting various modifications, pending a favorable tax ruling from the IRS.
Original Terms of Trust
The original trust included these conditions:
While the child is living, the trustee pays so much of the proceeds as the trustee deems necessary for the health, education, and support of each member of the class consisting of the child, the child's first grandchild, and the first grandchild's descendants. When the child dies, all principal and accrued income will be distributed to the child's first grandchild, otherwise to the first grandchild's descendants, provided that a beneficiary's share is added to an existing trust that the trustee then holds for the primary benefit of that beneficiary. The settlor's will provides that any trust in existence 21 years after the death of the settlor's last survivor and the settlor's descendants living at the time of the settlor's death will then terminate.
The trustee provisions provide, in relevant part, that no beneficiary can become a trustee and no beneficiary can be appointed with the power to remove trustees.
State statute provides that the court may modify the terms of the trust or change the trustee at the request of the trustee or beneficiary if the order learns the purposes of the trust.
Proposed modifications
The court order proposed modifications to the distribution provisions so that property that originally passed without trust to a beneficiary would be held in a separate trust for the beneficiary's lifetime. First, any distributions of trust income to the child's grandchild or more distant descendants during the child's lifetime can be held in a separate trust of which the descendant is the lifetime beneficiary. Second, any distribution of income or principal from the trust to the child's grandchild or most distant descendant at the child's death will be held in a separate trust of which that descendant is the lifetime beneficiary. Third, the beneficiary of any separate trust will have a general power of appointment (GPOA) under IRC Section 2041(a)(2), which makes the trust property excludable to the beneficiary's gross estate at death theirs.
In addition, the court order proposed various modifications to the trustee's removal and succession provisions, including that certain beneficiaries have the power to individually or jointly appoint co-trustees and successor trustees and that an appointed The trustee cannot be a beneficiary or a related or dependent party under IRC Section 672(c).
GST trust modifications
Treas. The rules. Section 26.2601-1(b)(4)(i) provides the parameters for modifications of a GST-exempt trust. Specifically, the following must apply: (1) the modification must be a valid judicial reformation or nonjudicial reformation under applicable state law, (2) the modification will not shift a beneficial interest in the trust to a beneficiary occupying a lower bracket than they held a beneficial interest before the modification, and (3) the modification does not extend the time for vesting a beneficial interest beyond the period provided in the original trust. Simple administrative changes that only indirectly increase the amount transferred will not be considered a shift of the beneficial interest.
IRS rules
Turning first to the question of whether the GST tax would be imposed as a result of the proposed modifications, the IRS determined that distributions passing to a trust that grants the primary beneficiary a GPOA under section 2041(a)(2) did not trigger the GST tax because the beneficiary the principal becomes the transferor on their death. The result is that the proposed modifications to pass the distribution to the trust in lieu of such beneficiary will not cause a shift of the beneficial interest to a lower bracket nor will they extend the vesting period beyond that originally provided in trust.
Similarly, the IRS ruled that the proposed modifications to the trustee removal and succession provisions are administrative in nature and only indirectly increase the amount transferred. Therefore, these changes to the trustee provisions will not cause the trust to become subject to GST.
The IRS further determined that because the beneficial ownership of the trust remained the same after the court's proposed modifications, no disposition or transfer subject to gift tax or recognition of gain or loss occurred.